Question

The initial graph shows the IS1 and LM1 curves, as well as the initial equilibrium. In this question, you will consider the effect of a spending shock to the economy and consider the different outcomes that result from different responses in monetary policy.

a. Suppose there is a decrease in planned investment by firms equal to 100. Furthermore, assume the marginal propensity to consume is 0.75. Determine exactly how far the IS curve would shift, then use the infinite line tool to construct the new IS curve, labelling it "IS2".

b. First, assume no policy response from monetary authorities. Using the double drop line tool , indicate the new equilibrium levels of Y and r in the economy, labelling this point "E2".

c. Suppose the monetary authority is concerned about the change in interest rates resulting from the IS shift, and intervenes to return interest rates to their initial level of 5%. Draw the new LM curve using the infinite line tool , and label it "LM2".

d. Using the double drop line tool , indicate the new equilibrium levels of Y and r in the economy, labelling this point "E3".

e. Suppose instead the monetary authority wants to return output to its initial level of 500. Draw the new LM curve using the infinite line tool , and label it "LM3".

f. Using the double drop line tool , indicate the new equilibrium levels of Y and r in the economy, labelling this point "E4".

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Answer 1

Date IS

a)

i2n On 100

TS IS

b)

Page No. Date: I от 2 TS TS' 凸匂 too 2

c)

Date: I 2 3 2. TS

d)

eate LM2 e2

e)

Page No. Date: I LM3 2 TS Mu

f)

Page No. Date: LH文 от LN3 ЕЗ 2 IS